Chapter 24 MONOPOLY. 24.1 Maximizing profits The monopolist will always set p=p(y). r(y)=p(y)y The monopolist’s profit-maximization problem then takes.

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Presentation transcript:

Chapter 24 MONOPOLY

24.1 Maximizing profits The monopolist will always set p=p(y). r(y)=p(y)y The monopolist’s profit-maximization problem then takes the form F.O.C.: MR=MC

24.1 Maximizing profits △ r=p △ y+y △ p Marginal revenue in terms of elasticity

24.1 Maximizing profits The F.O.C. becomes Maximum can only occur where |  |≥1.

24.2 Linear Demand Curve and Monopoly Linear demand: p(y)=a-by Revenue: r(y)=p(y)y=ay-by 2 Marginal revenue: MR(y)=a-2by The marginal revenue curve is steeper than the demand curve. The optimal output is given by the intersection of the marginal revenue curve and the marginal cost curve. The price is determined by the output and the demand curve.

24.2 Linear Demand Curve and Monopoly Monopoly with a linear demand curve

24.3 Markup Pricing The amount of the markup depends on the elasticity of demand. The market price is a markup over marginal cost.

EXAMPLE: The Impact of Taxes on a Monopolist Linear demand and taxation The price will rise by half the amount of the tax. Price will increase by more or less than the amount of the tax for other demand functions.

24.4 Inefficiency of Monopoly The monopolist charges a price higher than marginal cost. The monopolistic output is lower than the competitive output. The monopolistic market is Pareto inefficient. The monopolist is better off than in the competitive market.

24.4 Inefficiency of Monopoly Loss in consumer’s surplus: A+B Increase in producer’s surplus: A-C Loss in welfare: B+C

24.6 Natural Monopoly Large fixed costs but small marginal cost. Competitive price is lower than the average cost. A competitive firm will make losses. The firm need to charge the average cost to break even. Output is lower than the efficient level. Cost measuring is critical.

24.6 Natural Monopoly

24.6 What Causes Monopolies? Minimum efficient scale (MES): the level of output that minimizes average cost.  A small market size is prone to monopoly.

24.6 What Causes Monopolies? Cartel: Several firms in an industry collude and restrict output in order to maximize total profits. OPEC, De Beers.